What we really need are State Banks like North Dakota has, where all the state's revenues are funneled into the bank, free of Wall Street influence, to be redistributed to the rest of the state's banks, and loaned out at reasonable rates for mortgages and farm loans (loaning to farmers was the major reason this banking system was set up in the first place in 1919). Loaning money this way - the way banks have for hundreds of years - means the banks have 'skin in the game' so it is in their interest to ensure their customers do not default. The system of aggragating loans into CDOs and CLOs ensures just the opposite: that loans will be made, quickly packaged up and sold to investors (mostly naive of the true risks). When the underlying loans go bust, as they are, the banks won't be on the hook financially, though they do still get to collect the collateral houses. By the way, the legality of a bank collecting the house for a loan they no longer have on their book, or even have title to, has been successfuly challenged in a number of cases, and foreclosures have been prevented that way. People should know their rights and not simply move out when a foreclosure notice comes due.
Getting back to North Dakota (ND). ND has 4% unemployment, a surplus(!), of over $1 Billion (in a state with only 641,000 people) and virtually no home mortgage defaults. The bank is flush with cash and is run conservatively the way most community banks are still run (remember, there are 8500 banks in the country; only about 100-200 are a problem, and only 19 pose systemic risk; the too-big-to-fail gang.)
In addition to every state getting its own bank, acting independently of Wall Street and the investment bank community, we need to rerequire capital ratios that simply won't let banks become too big to fail - investors are NOT going to put all their money into a single one of anything, no matter what the derivative instrument. If we went back to 10:1 asset to liability ratios, a JP Morgan could never have 92 Trillion in Derivatives, as it does now - they would need almost 10 Trillion in assets first, and that's just not going to happen; the entire asset base of JP Morgan is probably 1/10th of that, and that's only if they sold off everything down to the light bulbs. In essence, they'd have to go bankrupt.
An astute regulator, one who is doing his/her job, would put a stop to such derivatives before they got to such ridiculous sizes. I still belileve, as I wrote in an earlier article, Saving the Economy Without Spending a Dime, that any derivative contract that was based on obviously insufficient collateral should be declared null and void by the Justice Department. This would prevent the cascade of failing institutions brought about by failure to collect on derivatives.
It's the derivatives market that's keeping Obama paralyzed with fear - though he's too cool to show it. If that truly breaks, and it will, there'll be no stopping the tsunami of defaults. It would be FAR better to gradually unwind this market first, slowly and deliberately.
I'm afraid they just don't get this in Washington; how could they? All the President's men (and here I am deliberately excluding Sheila Bear, because she alone seems to be doing a good job of regulating and closing down failing banks), are trained in the leveraged banking system, where bigger bets generate bigger rewards, and losing bets generate, well, bailouts. Oh, I know, the institutions involved will say their derivative "bets" (and they are bets, and as such, they should be treated like gambling investments, for that's what they are) are balanced, so that if one goes up the other goes down. Well, imagine you have a ton of bricks in one hand and ton of rocks in the other; are you "balanced" or are you simply being crushed by your holdings? The answer is obvious, and can only be papered over for a while. When someone tries to actually collect on these "investments" we'll see how empty the promises to pay really are, and no amount of fictitious money from the government will wipe away trillions in derivatives.
I think it may be politically impossible to get these necessary reforms, let alone a national bank that just makes loans at 3%, while the power to print money returns to its assigment to Congress, as stated in Article 1, Section 8 of the constitution. Creating state banks - who have no power to coin money, and who have "skin in the game" by keeping all loans on their own books, would accomplish much the same thing, and Governors would be onboard since it would give more power back to their states. This would overcome what is sure to be vicious opposition from the commercial banking sector to the effective reduction of power of the Federal Reserve.
Something like this will have to be done, and soon, to end the shadow banking system. The next crash will not be amenable to increased fiat money. Already, China and the other BRIC nations are talking about finding an alternate world currency in Yekaterinburg for commodities besides the dollar. If the world moves off the dollar standard, it's game over for the U.S. as our dollar will be shown to be the devalued currency it truly is, we will have to pay vastly more for imports (our manufacturing base will take years, or even decades to rebuild), and our standard of living will plunge. We will become Portugal, if we're lucky, or Zimbabwe if we're not.
I hope Obama has the audacity to act before it's too late.